Vivu Ltd. is a reputed chemical producing company. Vivu's shares are quoted in the market at the price of ₹340. Roma Mutual Fund's manager is thinking to buy the shares of Vivu. Advice the manager of Roma with respect to

CS Professional · Financial, Treasury and Forex Management · PYQS · June 2018
Vivu Ltd. is a reputed chemical producing company. Vivu's shares are quoted in the market at the price of ₹340. Roma Mutual Fund's manager is thinking to buy the shares of Vivu. Advice the manager of Roma with respect to buy decision through the application of Gordon model based on the following information. (1) The expected rate of return by equity shareholders is 10%. (2) The retention ratio is 40%. (3) The earnings per share recorded in the recent past year is ₹20. (4) The expected earnings per share for next year is ₹25. (5) The internal rate of return of Vivu Ltd. is 15%.

Answer & Explanation:

According to Gordon model, P = E(1-b)/(k e -br) where P = Market price of equity share E = Earnings per share b = Retention ratio k e = cost of equity share capital br = growth rate of the firm P = {25(1-0.40)}/{0.10-(0.40*0.15)} = 15/0.04 = ₹375 Decision: As the price of the share of Vivu Ltd. quoted in the market (₹340) is less than the market price derived as per Gordon model (₹375). Therefore, Roma Mutual fund should buy the shares.

Topics: Equity Valuation

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